The Small Business Financing Spectrum

9 minute read

It is no secret that one of the biggest challenges for anyone starting a small business is funding. For a lucky few the solution is easy – they actually have the money spare. For a much larger group they are ‘banking’ on one of the commonest sources of funding for all small businesses and startups – friends and family. Still others do their best to make it work using the easiest source of capital – personal credit cards. The largest group is still business loans from banks but it is a shrinking percentage and increasingly difficult and time-consuming. The difficulty of getting a bank loan has led to a huge rise in alternative funding sources from crowdfunding to alternative lenders to peer-to-peer lending to all kinds of hybrid arrangements.

So what is a small business to do?

Here’s some data to put the whole issue into perspective.

The vast majority of small businesses are VERY small. According to the US Census Bureau, in 2011 there were 22.5 million non-employer businesses in the US (a non employer business is one with no employees that pays taxes and has annual receipts of over $1000). Essentially these are all the one person businesses. And in the same year there were an additional 5.5 million small businesses (businesses with fewer than 500 employees) that did have employees. Total revenues just from the non-employer businesses was $989.6 billion.

According to OnDeck Capital the median capital sought by small businesses is $44,000. And in their survey 15% of businesses did not seek capital because they already had it. 30% did not seek it from conventional sources even though they needed it. 55% applied for financing and of those 82% were turned down for bank loans. Note that there are reports that the very tight situation for bank lending is beginning to ease but it is still far harder to get a small business loan than it was prior to the financial crash.

This need for financing and the difficulty of getting it from conventional sources has led to a much wider spectrum of financing possibilities than was previously available, ranging from government grants all the way down to personal credit cards and high-asset lenders or pawnbrokers. All of these have advantages and disadvantages. Here is a quick run down along with as comprehensive a list of sources as we could manage.

There are some important factors to consider with ANY form of funding. These include:

Time – how long will it take to get the funding you need? You need to consider this and how you will keep your business afloat or keep working toward starting it in the interim.

Complexity – how much paperwork will there be? Will there be background checks, What about additional certifications or collateral? Will interviews be required?

Costs – What are the interest rates? Make sure to convert all funding sources to a comparative standard like APR. What are the fees. Are there origination fees, are there monthly fees, are there early payment penalties? Are there termination fees?

Risks – is there any possibility of the lender activating an early termination and demanding their funding back? How is money transferred and supplied? Could inadvertent delays trigger higher costs?

Term – how long is the period of the loan? Obviously a loan for a period of ten years is very different than one for a period of three months. Is it renewable?

Size – look at the affect of size. Does the lender have different rates for different amounts? Could you save money in the long run by borrowing a little more or a little less?

Penalties – read the fine print. You need to pay attention to any penalties for early or late payments, for delays, for changes to the agreement or any other issues that could materially affect the value of this loan to your business.


Funding Sources or Choices


Self funding and bootstrapping

In some ways this is the ideal – you don’t need to get external funding (which always comes at some kind of additional cost) and you are in control of your funding destiny. You use whatever resources you have on hand to get your business to the next level – from sources like savings, home equity loans and credit cards. Bootstrappers tend to operate on very, very lean budgets.

Pros: simple, easy, quick and you are in control. Low cost, low complexity and no worries about term or about penalties.

Cons: High risk – this is your money. If your business fails it is your money that is gone. Size – you are limited to the funding you have. If you need more you are still going to need to turn to one of the other funding sources.


Friends and Family

This is a common fund raising approach and one that is very hard to track. It is common for small businesses to get loans from friends and family to start a business and the terms are obviously settled between the parties and private. It’s a good approach if your friends and family think you are a good risk and trust you. They will provide you funding at terms that are likely to be far more favorable than you will get elsewhere. Of course they are friends and family and failure can put some very important relationships at risk.

Pros: Terms, cost, penalties, control, risk.

Cons: These could be variable and include a real gotcha that could make any entrepreneur think twice – the need to answer to people to whom you are close and who have immediate and frequent access to you. Other potential gotchas include term – friends and family may suddenly really need their money back – and amount in that you can only raise from friends and family what they have and are prepared to share. The final gotcha could be time – in that in a relationship that is inherently slightly less professional there will not be as much incentive to provide funds exactly when they are promised.


The Government

In many ways this is the best option for small business funding. Government grants are plentiful and typically come with some additional support. They also provide evidence to potential partners and customers that the government has a certain level of confidence in your business. But they are very slow and complex to apply for and to receive. Typically you would apply for a government grant in parallel with applying for other sources of funding. Some of the sources are federal and state agencies, Small Business Innovation Research Grants (SBIR) and Technology transfer grants (SBTT). Grants are especially advantageous because you do not have to pay them back!

Pros: Rock solid, terms and costs are very clear and there is lower risk than most alternatives

Cons: Complicated and lengthy to acquire. You will have to provide more details about you, your background and your business than you can possibly imagine. There is a timeline you must adhere to with high levels of accountability. There may be penalties if you do not keep up with the execution requirements.

 ['s loan and grant links, open grant opportunities]


Funding from banks is the traditional way to get a loan to start a business. And it remains the single largest source and most popular choice. But compared to forty or thirty or twenty or even ten years ago it is MUCH harder to get a loan from a bank. The good news is that it is easier than it was a year ago. A year ago it was essentially impossible. But banks are lending again. However, the financial crisis has led to banks applying more stringent requirements, doing more substantial background checks and making terms more onerous than previously. Nevertheless, this remains an important source of funding and you should in particular try to make connections with a local bank.

Pros: Easy to apply, terms and costs usually good and clear. Length is flexible. Risk is low.

Cons: Little flexibility if you are unable to meet terms. Low approval rate. Application process can vary.

['s list of the most active small business banks for loans]

Venture Capital

Getting funding from venture capitalists is a much tougher proposition than pretty much any other choice here. It requires a serious level of pitching work to tens or more of companies and it requires the company owners/founders to put in a lot of time learning the ins and outs of the venture capital world. It also means giving up far more control and ownership of a company than almost any other option here. The upside is that you can quite possibly raise significantly more funding than any other way. You also have to meet a different set of criteria for investment. Companies that can get venture funding may not actually be able to get bank funding and vice versa.

Pros: can raise much larger amounts than any other way, often comes with a network of advice and support that can be invaluable, no or few penalties, no fixed length, risk is very low

Cons: terms are very different and more onerous in some regards, less in others, give up some control, give up some ownership, time consuming application and process.

[ advice about venture capital]


Angel investors are the new VCs. The easiest way to think of them is mini venture capitalists. They are private individuals with lots of spare cash for investing bit compared with VCs they typically give less in funding and take less and offer less in the way of extras. But they are easier to raise money from in general and take less control and ownership of a company while still providing valuable advice and contacts. A typical scenario is that a tech startup will get enough funding from self and family funding to put together enough of a prototype to get angel investment which then lets them grow and build a better product which in turn might get them VC funding.

Pros: similar to venture capitalists but a little more lightweight – less money, less support

Cons: also like VCs but less so – you are giving up some ownership and control. Process can be lengthy and cumbersome.

 [AngelList, The 20 Most active Angel Investors]

True Crowdfunding

Crowdfunding is the hot funding topic. But it is a lot more complex for a business than it may seem at first. There is confusion about what it is and its ramifications for a business can be quite a lot more complex than most people think. True crowdfunding belongs to platforms like Kickstarter and IndieGoGo. And even these differ a great deal in detail. But the essence is that you pitch a product or service to the public online using the crowdfunding platform and people decide to fund you or not as they see fit. Typically a large number of people fund your project just a little bit. In some models you have to hit a preset target to get any funding. In others you get whatever you raised along the way. Typically, however, there is some threshold you have to pass before this works at all. It works well for new products that depend a great deal on sales and popularity and crowdfunding serves as a combination of pre-sales and publicity to determine if there is sufficient demand.

Pros: Easy to set up, low risk, you set terms.

Cons: Hard to raise money above a very small amount, works better for very specific scenarios, penalties/restrictions on funding can be quite limiting

[KickStarter, IndieGoGo]

Debt/equity crowdfunding

Debt and equity crowdfunding are very new types of funding that have come about because of changes that are currently underway in the way that business funding may occur. They are basically crowdfunding where instead of a product or service on offer and which the ‘crowd’ gets in return for funding, the ‘crowd’ gets interest on its money or a small amount of ownership in the company in some way. Note that currently in practice these are still limited for participation to institutional investors, meaning that they are not really crowdfunding at all in the true sense. However, the models for how they would work are being built out in anticipation of rule changes that would allow anyone to participate.

Pros: relatively easy to set up, low risk

Cons: still in infancy, terms are highly variable, high risk because of possibility of legal and law changes


Online business loans and lines of credit

This is a relatively new category of lender that is taking advantage of the growth in online businesses and businesses with enough exposure online that the lender can find out information about the creditworthiness of the business relatively easily. These companies (Kabbage and OnDeck are leading examples) offer very fast loan decisions, easy applications and straightforward tools to help businesses get money quickly. They use information about online sales and other available online information to make lending decisions quickly. They also have very clear policies. Unfortunately the cost of getting the capital is currently rather high with interest rates considerably higher than many other funding sources.

Pros: easy decision, quick, low risk

Cons: high interest and tougher terms

[Kabbage, OnDeck]

Crowdsourced loans – peer to peer lending

Another relatively new option. Sites like Prosper and Lending Club offer loans for all kinds of purposes, including business. The funding is crowdsourced from a large group of ‘investors’ and terms are set in advance and are quite clear. In some cases the loan is just from one individual and in others the loan can come from a pool of lenders. The risks are assumed primarily by the pool of lenders but interest rates can rapidly get quite high if the borrower cannot provide clear evidence of great creditworthiness. Rates at the time of writing tend to be very competitive if your credit is really good and average to poor as your creditworthiness declines.

Pros: possibility of getting funded if facing issues elsewhere, fairly quick, low risk

Cons: not 100% sure of getting funded.

[Prosper, LendingClub]

High value asset lenders

This is a rare and unlikely source of funding but can have its moments (see our story on SF Provident). Basically we are talking about reputable and low interest rate pawnbrokers that prefer to lend on high value items with customers that they expect to reclaim the merchandise rather than forfeit it. The rates can get pretty high for longer term loans but for terms of 3 months or less and for repeating and predictable but low risk loans they can be a good deal.

Pros: fast and easy to get money. Predictable.

Cons: terms could be difficult and rates get high for longer periods.



Online credit and funding brokers are also a relatively new source of funding. They aren’t actually a source per se but they will broker a range of sources against your profile and give you some options when looking for funds in one place, saving time and aggregating responses. The advantages are they can often give you a wider range of options that have said yes or will say yes. The disadvantages are that they do not include all the options so if you are in a position looking for funding that is more unusual they may be no help.

Pros: range of choice

Cons: range of choice, slight overhead/fee

[Fundera, Fundation, DealStruck, Biz2Credit]

Hybrid funding

Although hybrid funding isn’t really a specific category, new lenders are entering the field that can combine loan types or offer terms and rates and amounts that differ from the types of funders already mentioned. In particular there are likely to be new crowdfunding hybrids as the proposed rules begin to come into force.